Europe’s institutional investors have largely turned their backs on currency managers after losses during the financial crisis, but investment consultants are recommending a long-term bet on one part of the foreign exchange market – for those with the stomach for a bumpy ride.

European pension schemes and insurance companies got excited about currencies in the last decade. The number of mandates awarded to currency managers grew from zero in 2003 to 61 in 2007, according to figures collated by Financial News.

These managers made money on the carry trade, borrowing in a low-interest rate currency and using the money to buy government bonds in a high-yield currency. But with the onset of the financial crisis in 2007 the carry trade, described as picking up pennies from in front of an oncoming steamroller, turned upside down, and investors lost heavily.

UK currency manager Auriel Capital lost 99.99% of the value of the assets it managed for the UK’s Pension Protection Fund over the three years to March 2010, according to the PPF’s accounts, published this month: on assets of £8,000,000 it made an investment loss of £7,999,000.

The number of mandates being awarded has tumbled, to just five for the first 10 months of this year, and many investors say they feel reluctant to try again.

Judy Saunders, chief investment officer of the West Midlands Pension Scheme, said: “Our experience was not good, primarily due to timing, so we have not put our toes back in the water. Never say never, though; I’m sure one day we will re-visit it.”

It is suffering from something that’s affecting the whole concept of active asset management: an active manager applies fundamental reasoning to investment opportunities, but the market is being driven by government moves that can come out of nowhere.”

This happened to currency managers in January, when the government of Chile, whose commodity exports made the peso attractive, suddenly imposed a new tax. The peso fell 8% against the US dollar. It was a similar story in September, when the Swiss set a ceiling on the value of the franc to the euro and the franc lost 9%.

Hastings said: “Clients say they cannot tolerate this sort of thing. Currency investing seems to be off the radar.”

Value to be found

Currency investing makes more sense to investors, however, when it is part of a broader investment approach. Investors are putting money into global macro, one of the few hedge fund strategies to take in money on a net basis in the third quarter of this year.

Currency investing is also being used by multi-asset managers, one of the most popular asset classes in the mainstream fund management industry.

Curt Custard, head of multi-asset investing at UBS Global Asset Management, said: “We see opportunities for trading in currencies. Currency is the last big lever a country can use to stimulate its economy, and we expect they will use it. It’s especially true of export-oriented countries.

“At the moment there is a particular opportunity with the euro. The currency is the one asset class in the eurozone that has not been reflecting the potential future instability of the euro. We have been short the euro against the dollar for a while.”

BNP Paribas Investment Partners added trading in G10 currencies to its dynamic asset allocation strategy in September but not because it saw more opportunities in the market.

Gina Wilton, an investment specialist in global balanced solutions at BNP Paribas Investment Partners, said: “This has been an awful year for the majority of currency managers, a lot of whom have suffered due to the high level of intervention we have seen by central banks around the world.

The main reason for adding currencies in our dynamic asset allocation fund was to give us greater flexibility in terms of the breadth of the investment universe and the types of positions we can take.”

Emerging strategies

Some advisers see an opportunity in relation to one part of the foreign exchange market: the long-term appreciation of emerging markets currencies against those of the developed economies. This is a carry trade, as investors are netting interest income, but there is a fundamental shift too.

Western economies need to become more competitive in global markets, which will come mostly through currency depreciation and emerging markets need to move to increase their domestic demand, which means appreciation.

Towers Watson constructed a strategy with currency manager Rogge Global three years ago to make money from any appreciation of emerging markets currencies. It’s a passive fund charging 10 basis points of assets under management – what Towers Watson calls “smart beta”.

Keith Guthrie, chief investment officer of consultant and manager Cardano UK, said his firm has also been advising institutional investors to take a long-term position on the appreciation of emerging market currencies.

Cardano is accessing the opportunity through active currency managers with experience in emerging markets, whom it directs through the use of a customised benchmark.

Guthrie said: “From a liquidity point of view there is no restriction on pension funds investing significantly in this: 5% to 10% of their portfolio could easily be done.

“However, investors who follow this trade should be prepared for pain, because it will correlate with equity and bonds, and with investors still flying to US dollars at times of stress this trade will hurt when you mark to market. It will probably play out over five years.”